Rent control, Alameda-style

When Council directed City staff last November to prepare an ordinance imposing rent control in Alameda, our elected officials probably expected to see a proposed law modeled on the rent control ordinances already enacted by seven other Bay Area cities.

Boy, are they in for a surprise!

True, like the laws adopted elsewhere, the Alameda rent control ordinance would set a “maximum allowable” rent increase.  Consistent with prior Council discussions (and the “urgency ordinance” establishing a 65-day “moratorium”), the increase permitted is a flat eight percent.

But that’s where the similarity between the ordinance drafted by the City Attorney and the laws in effect in other jurisdictions ends.

In fact, the proposed Alameda ordinance is one of a kind.  It treats the determination of whether a proposed rent increase is “reasonable” as an accounting exercise rather than a policy judgment.  What’s more, it offers none of the avenues available elsewhere to a landlord to recoup any extraordinary costs incurred to maintain or improve her property.

If the proposed ordinance is intended to induce landlords to charge the “maximum allowable rent” and not a penny more, the draft accomplishes that goal.  But if the objective is not just to prevent landlords from imposing “excessive” rent increases but also to encourage them to benefit tenants by rehabilitating or upgrading their buildings, it falls well short of the mark.

Comparing the proposed Alameda ordinance with the rent control laws in other Bay Area cities, the Merry-Go-Round noted four major differences.

All but one of the rent control ordinances adopted by other Bay Area cities allow a landlord to “bank” rent increases – i.e., to make up the difference later if she charges less than the otherwise permissible maximum rent in a given year.

The Alameda ordinance does not.

All but one of these ordinances identify certain factors that, if they’re found to exist, may entitle a landlord to raise rents above the specified maximum.

The Alameda ordinance does not.

In addition to listing reasons justifying a rent increase, the majority of the ordinances adopted elsewhere identify certain costs that the landlord may be authorized to “pass through” to the tenant without having them count against the cap.

The Alameda ordinance does not.

Finally, all of these ordinances entitle a landlord or tenant to appeal, without having to go to court, an initial decision denying or granting a rent increase greater than the cap.

The Alameda ordinance does not.

We have no idea why staff chose to reject the approach taken by virtually all of the other Bay Area cities that have enacted rent control ordinances.  (We’re assuming – perhaps charitably – that it was a choice by staff rather than an oversight by the drafters in the City Attorney’s office).  But each of the omissions has consequences.

Let’s start with “banking.”

Every city except for Berkeley permits the practice.  For example, the City of Oakland restricts annual rent increases to an amount based on increases in the Consumer Price Index.  But the Oakland rent control ordinance allows a landlord to “delay imposing in part or in full” the annual CPI rent adjustment and charge it at a later date.  Under the implementing regulations, the difference between the permitted CPI rent adjustment and the actual rent “may be carried over to succeeding twelve (12) month periods” for as long as 10 years.

The failure to include a similar provision in the Alameda ordinance sends a “use it or lose it” message to local landlords:  If you don’t raise rents this year by the maximum allowable amount, you can’t make up the difference any time thereafter.

Even more disturbing is how the proposed Alameda ordinance deals with requests by landlords to increase rents beyond the annual eight percent cap.

The draft law recognizes, as it must in order to be deemed constitutional, that a landlord should be able to charge more than the otherwise permissible maximum if necessary to achieve a “just and reasonable return.”  But the standard way of dealing with this requirement is either to set forth a list of factors that may justify a rent increase in excess of the cap, or to allow the landlord to “pass through” certain costs without having them count against the ceiling.

The ordinance adopted by the City of Hayward furnishes an example of the first approach.  After setting a five percent cap on annual rent increases, the Hayward ordinance authorizes a landlord to charge more based on one or more of the following factors:

  • “Unavoidable” increases in maintenance and operating expenses;
  • Costs incurred for “substantial” rehabilitation or capital improvements;
  • Increased costs of debt service due to sale or refinancing of the rental units or the apartment building;
  • The “rental history” of the unit or the building;
  • The physical condition of the unit or building;
  • Any “increase or reduction of housing services” since the last rent increase;
  • Other financial information “which the landlord is willing to provide”;
  • Existing market rents for units “similarly situated”;
  • A “fair return on the property prorated among the units of the complex.”

In addition to enumerating factors that may justify a rent increase above the otherwise permissible maximum, four of the rent control ordinances adopted by other Bay Area cities provide for pass-throughs of specific costs.  These costs may be included in the rent over and above the increase permitted by the cap.

For example, the City of Los Gatos limits annual rent increases to 70 percent of the increase in the CPI or five percent, whichever is greater.  The Los Gatos ordinance provides a list of six factors for an arbitrator to take into account in determining whether to approve a proposed rent increase in excess of the ceiling.  But the ordinance also states that, in any event, a proposed increase will be deemed reasonable if it consists of no more than the five per cent maximum plus the pass-through of:

  • The regulatory fee;
  • Costs of capital improvements, averaged on a per-unit basis and amortized over a period of not less than sixty (60) months;
  • Increased costs of maintenance and operation; or
  • “Documented costs” of rehabilitation; averaged on a per-unit basis and amortized over a period of not less than thirty-six (36) months.

In addition, the ordinance allows the landlord to pass through the costs of debt service on a loan obtained in a “secured, arm’s-length transaction” if certain conditions are met.

The proposed Alameda ordinance takes neither the factor-based nor the pass-through approach.  Here’s what it says – and all it says – on the subject of a landlord’s right to charge more than the “maximum allowable rent”:

In determining petitions concerning a fair rate of return on property, the hearing officer shall take into account the purposes of this Article to eliminate imposing excessive rent increases while providing housing providers with a just and reasonable return on property.  The hearing officer shall not determine just and reasonable rate of return solely by the application of a fixed or mechanical accounting formula but there is a rebuttable presumption that maintenance of net operating income for the base year, as adjusted by inflation over time, provides a housing provider with a just and reasonable rate of return on property.

Got your Excel program loaded and your book of accounting rules handy, Madam Landlord?  You’re going to need ‘em.

To apply the “presumption,” the landlord must compute “net operating income” for the “base year” (this is made a defined term; it turns out that all it means is “2015”); adjust that number for inflation (the ordinance does not state what index to use), and then compute “net operating income” for the current year.  “Net operating income” is simply the difference between “gross revenues” and “costs of operation.”  But the landlord may need to bring in her C.P.A. to perform the calculation:  It’s easy enough to determine “gross revenues.”  But “costs of operation” are defined to exclude certain costs and to include – but not be limited to – certain other costs, and the list is hardly comprehensive.

The only other Bay Area city that turns the determination of a “just and reasonable” return into this kind of accounting exercise is the City of East Palo Alto.  But East Palo Alto’s ordinance is more punctilious than Alameda’s.  Not only does it contain more detailed definitions of revenue and costs, it acknowledges that the computed “net operating income” may need to be adjusted to ensure a “fair” return.  For example, adjustments may occur where the landlord’s operating and maintenance expenses in the base year were “usually high or low,” or the rent on the base date was “disproportionate.”  The proposed Alameda ordinance does not provide for any such corrections.

We would have been more comfortable if the drafters of the Alameda ordinance had followed the norm.  The factor-based method used by other Bay Area cities to determine a “reasonable” rent doesn’t strike us as especially arcane.  After all, deciding an issue based on consideration of a list of relevant factors is what judges and juries do all the time.  It is, for example, the way in which the trier of fact determines such basic questions as whether the defendant owed a duty of care to the plaintiff.  Deciding an issue based on application of an accounting formula . . . well, that’s just a little bit too “mechanical” for our tastes.

Moreover, the approach taken by the other Bay Area cities strikes us as more pragmatic than the one used in the proposed Alameda ordinance.  The “net operating income” method takes account of the ordinary costs involved in renting residential property – but it ignores the extraordinary expenses a landlord might incur in maintaining or improving the building.  The ordinances adopted elsewhere also recognize, in one way or another, that where a landlord dips into her pocket to rehabilitate or upgrade the property, and thereby benefits tenants, it’s only fair to allow her to recover a portion of those costs through rent increases greater than those otherwise permitted.

The draft submitted to Council may not be the last word on this subject.  According to the staff report, within the next 45 days, staff intends to prepare “policies and procedures” that will “create a framework as to how the rents will be determined following the capital improvements (e.g., will rent increases over the threshold amount be subject to RRAC review or involve the hearing officer petition process, etc.).”  What this “framework” will consist of – and whether it will cover anything other than capital improvements – is anyone’s guess.

Finally, if Council adopts the proposed ordinance, Alameda would be unique in providing for no administrative appeal of a decision denying or granting a request for a rent increase above the cap.  The process followed elsewhere takes one of two forms.  Under one, a mediator initially decides whether to allow the increase.  If either party is dissatisfied, she can present her case to an arbitrator.  In the other, a hearing examiner makes the initial decision, which the landlord or tenant then can appeal to an elected or appointed board.

Unlike the other deviations from the norm, this time the staff has provided an explanation for its choice.  “Given the highly technical nature of evaluating fair and reasonable return,” the staff report says, “it is appropriate that a trained hearing officer render decisions that can be reviewed judicially rather than be appealed to a lay board or city council.”  Really?  Admiring as we are of the judiciary, we fail to see why a judge is more capable than a lay board, or, heaven forbid, a city council to make the final decision about what is “fair and reasonable.”  It’s not as if the ultimate ruling on reasonableness depends solely on how well the “trained hearing officer” crunched the numbers – oh, sorry, under the proposed Alameda ordinance, we guess it does.

It’s unfortunate that staff has presented Council with a rent control ordinance like this one.  How to solve the “rental crisis” in the City poses a host of difficult policy choices.  Our elected officials should be free to focus their attention on weighing the competing arguments.  They shouldn’t have to spend time wondering why the law in Alameda should be so different than it is in every other Bay Area city that imposes rent control – and then, if there’s no good reason for the difference, re-writing the ordinance on the fly and after midnight.

If we were cynical, we’d suspect that staff came up with a proposed ordinance designed to displease both tenants – because the cap is so high – and landlords – because the ability to recover costs is so limited.  If so, the problem is easy enough to fix.  First, our Council members can reduce the cap (or tie it, like most other rent control ordinances in Bay Area cities, to increases in CPI).  Then, they can hire an outside law firm to write a law that encourages landlords to devote their resources to maintaining and improving their properties rather than finding the cleverest accountant.  Can we count on three votes?

Sources:

Staff report: 2016-01-05 staff report re proposed ordinances

Draft Alameda rent control ordinance: 2016-01-05 – Ordinance 22016-01-05 – Ordinance 3

Berkeley rent control ordinance: Berkeley rent stablization ordinance

East Palo Alto rent control ordinance: East Palo Alto rent control & just cause eviction ordinance (2010)

Hayward rent control ordinance: Hayward rent control & just cause eviction ordinance (1983)

Los Gatos rent control ordinance: Los Gatos ordinance

Oakland rent control ordinance: Oakland rent adjustment ordinance

San Francisco rent control ordinance: SF rent control ordinance (full)

San Jose rent control ordinance: San Jose rent control ordinance

 

 

About Robert Sullwold

Partner, Sullwold & Hughes Specializes in investment litigation
This entry was posted in City Council, Housing and tagged , . Bookmark the permalink.

13 Responses to Rent control, Alameda-style

  1. Erik says:

    Unique to Alameda is our very old housing stock. Expensive to maintain, now with the newest buildings over 50 years old and requiring major renovations to mechanical systems to remain in service. A huge lack of understanding of this on the part of the participants. This is a recipe for a significant loss of Alameda apartment units. A shrinking and unsustainable housing stock will be the outcome here.

  2. Meme says:

    Have you looked at the Grand Jury reports re: Berkeley?

  3. John K says:

    Mr. Sullwold provides the usual valuable insights and common-sense suggestions. However, he seems to have gotten side tracked, along with City staff, to the issue of ‘just and reasonable returns’ for the landlords and how best to achieve that. I say side tracked because those aren’t the problems the Mayor and Council were asked to solve.

    Rather, as stated in the opening recitals of the ordinances, the problems are ‘substantial increases in rent and in evictions for no-cause.’ When one reviews the article from this perspective, one finds it nearly mum on these issues and we find only combination after combination of formulas to determine ‘fair return.’ We can’t really blame Mr. Sullwold for this, though, since he’s responding to what’s in the ordinances themselves which are, of course, the result of landlord and real-estate interest lobbying. Those interests have thus far been successful at diverting the ordinance-writing task into an exercise of guaranteeing their right to returns to the nearly total exclusion of solving the problems of rising rents and no-cause evictions.

    Pity the hapless renter who strands by as the politicians, landlords, lawyers, real estate agents and accountants wrangle over the best and most precise way to raise her rent higher than eight percent.

    If the ordinances don’t help keep rents affordable for Alamedans or help keep families in their homes, they don’t solve the problem, no matter how many accountants and trained hearing officers you have.

  4. John K says:

    Mr. Sullwold provides the usual valuable insights and common-sense suggestions. However, he seems to have gotten side tracked, along with City staff, to the issue of ‘just and reasonable returns’ for the landlords and how best to achieve that. I say side tracked because those aren’t the problems the Mayor and Council were asked to solve.

    Rather, as stated in the opening recitals of the ordinances, the problems are ‘substantial increases in rent and in evictions for no-cause.’ When one reviews the article from this perspective, one finds it nearly mum on these issues and we find only combination after combination of formulas to determine ‘fair return.’ We can’t really blame Mr. Sullwold for this, though, since he’s responding to what’s in the ordinances themselves which are, of course, the result of landlord and real-estate interest lobbying. Those interests have thus far been successful at diverting the ordinance-writing task into an exercise of guaranteeing their right to returns to the nearly total exclusion of solving the problems of rising rents and no-cause evictions.

    Pity the hapless renter who stands by as the politicians, landlords, lawyers, real estate agents and accountants wrangle over the best and most precise way to raise her rent higher than eight percent.

    If the ordinances don’t help keep rents affordable for Alamedans or help keep families in their homes, they don’t solve the problem, no matter how many accountants and trained hearing officers you have.

    • David says:

      The ‘fair return’ question is important, because if the ordinances cannot withstand a legal challenge, on the basis of not permitting a ‘fair return,’ they could be struck down and invalidated, thereby protecting no tenants.

      • John K says:

        Council member Ashcraft, in her comments in the early hours of Nov. 5, said she asked a group of landlords what percent return they need to maintain and operate their properties and make a fair return. She said they were very specific with her and, although she did not divulge the exact information, she said it “did not approach 8%.” To date, I’ve not seen a single piece of data that supports the need for 8% rent increases. That’s why I characterize the extended discussion of fair return above that as being side tracked.

      • dave says:

        John K

        I suspect you may be confusing cap rates with rent increases.

        The cap rate is a way of expressing an expected annual return on a real estate investment.
        https://en.wikipedia.org/wiki/Capitalization_rate

        In this era of low interest rates and higher asset prices, cap rates are typically well under 8%. I am aware of a large transaction of many rental units that recently occurred in the Bay Area at an average cap rate of approx 5.5%. The mid/high 5% area has been a good rule of thumb lately, though duplexes often trade at much lower cap rates. The property at 470 Central was advertised at a 6.25% cap rate. It looks higher than average because the building needs significant upgrades & repairs. When those costs are included the building’s realistic cap rate will be much lower unless/until rent increases happen.

        To achieve and maintain a given cap rate will require some rent increases at various times. It will likely be less than 8% in most situations, but not all. Expenses can increase a lot faster than 8% a year and Alameda’s generally older housing stock is expensive to maintain.

        Note also that Alameda’s rents were flat/down for a decade between the tech booms.

      • David says:

        “Council member Ashcraft, in her comments in the early hours of Nov. 5, said she asked a group of landlords what percent return…”

        Your response doesn’t change anything. And I fear you are missing the point.

        It takes only one landlord to challenge the ordinance on the basis that it doesn’t permit ‘just and reasonable returns’ to potentially have the ordinance thrown out, thereby removing protections for renters.

        The lower the limit on annual rent increases, the greater the risk of a legal challenge.

  5. Keith Nealy says:

    Has anyone thought about the cumulative effect of 8% compounded annually? In 5 years it’s nearly 50% more. Where else can I get an 8% return? This is huge. Especially considering a CPI of a fraction of that. Is anyone getting 8% raises in salary?

    • David says:

      Has anyone looked into the components of CPI? The “C” in CPI is for “consumer” – it measures things like the price of bread and milk and other consumer expenses. There are very few, if any, landlord cost inputs reflected in the CPI.

      Property taxes, for example, are going to go up in the double digits this year and next for many property owners, but CPI doesn’t measure property taxes.

      Tying rent increases to CPI is an attempt to limit increases to renters’ ability to pay, which may or may not have anything to to do with the cost of maintaining the housing.

      If landlord costs increase in excess of CPI, it can drive landlords out of business (over time) ultimately removing units from the market.

  6. dave says:

    For over a decade (2002-2012) rents in Alameda were flat to lower even while owners’ expenses continued to rise. An 8% max does not mean 8% every year and never has.

  7. wordist45 says:

    (Thanks for your well-written comprehensive article on a VITAL topic. Below are my comments delivered at last night’s city council meeting on Topic 6c, Rent Control Ordinance.)

    Long-term Alamedans, a Predator’s Prey

    “Joe” is a disabled Viet Nam-era ex-Marine who spends over half his income on rent. Joe’s savings were obliterated by medical bills and therapy for PTSD. An eight-percent rent increase for him is constructive eviction.
    Until recently, Erica lived next door to Joe on Santa Clara. She’s a single mom flight attendant. In the summer of ’93, Beulah from Berkeley bought Erica’s building and jacked up the rents 30%. This summer, Erica and her six-year-old son received a no-fault eviction so this new landlady, Beulah, could re-do the floors and kitchen and increase the rent to twice what it was when she bought the place the previous year.
    Until recently, Linda lived in Erica’s building for twenty-eight years. She’s a legal secretary in San Francisco with a Boston accent. After seeing what happened to Erica, Linda moved out.
    Joe is aware that Beulah-from-Berkeley has been trying to buy his building. “I wish Linda hadn’t moved away,” he told me one day, gazing out his window at the newly painted building next door. “I miss watching Erica play Frisbee with her son. I feel like some kind of prey, and Beulah’s the predator.”
    Joe and I go to church with “Elsie,” who lives just down the street. Elsie’s ninety years old, a thin wisp of a woman who’s shared the wisdom of her years by publishing three memoirs in her eighties. Elsie has a heart condition. She’s frail. Her life could be snuffed out because some realtor wants to MAKE, MORE, MONEY!

  8. wordist45 says:

    One of the reasons we’re having this problem is a four-page color spread published last summer in the Sunday San Francisco Chronicle touting the quality of life and low rents in Alameda. This unprecedented marketing of Alameda obviously targeted the more mobile victims of the housing crisis there.

    To people who’d been looking at $3,000 for a one-bedroom flat, $2,000 in Alameda was cheap, but to Alamedan’s who’d been paying $1,200, it’s a crisis.

    Who but a pack of realtors would have placed that ad?

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